Goldcorp: Expansion Projects Will Outweigh Risks

Despite its recent losses, I believe Goldcorp Inc.(NYSE:GG) is still a good buy because of its high earnings per share. In the second quarter of 2012, the Canadian miner paid earnings of 41¢ per share, despite a 20% drop in earnings during the same period. Goldcorp's earnings were down because its production fell. The company only produced 578,600 ounces of gold during the second quarter; it mined 597,100 ounces during the same period last year. That means Goldcorp's production has dropped by 20% in the past year.

The company's chief executive, Chuck Jeannes, blamed the drop in production on problems at two of the company's biggest mines Red Lake in Ontario and Penasquito in Mexico. Jeannes told the press that problems reaching high grade ore at Red Lake and a water shortage at Penasquito were driving up costs and cutting production.

Rising costs, rather than falling production, are the biggest threat to Goldcorp's future profits. It cost the company $619 to mine an ounce of gold in the second quarter of 2012, as opposed to $553 to dig out the same metal in the same period in 2011. Goldcorp's production costs went up by $66 per share in just one year. If the same thing happens next year, production costs will have gone up by $100 a share in just two years.

That would cut into both profits and earnings per share. If this year's losses were to be repeated next year, Goldcorp's profit will fall by another 20% or 40% in two years. In this scenario, the company's profit for next year would be around 32¢ a share. This shows what a risk Goldcorp really is, and even though it's still paying a nice little profit, it's facing the potential of serious losses.

These figures don't take any other potential losses, such as problems at Goldcorp's other mines, into account. If the company faces any other serious losses, we could see further drops in profits and a cut in share value.

That would put Goldcorp into a situation similar to its largest Canadian competitor, Barrick Gold (NYSE:ABX), which has been losing value, despite high gold prices. Barrick's share value hit a three-year low last month after the company reported a 35% drop in second-quarter income.

Keep in mind that Barrick and Goldcorp are in different situations. Goldcorp's losses appear to be from standard operational losses in mining, while Barrick has a host of other problems, including a recent management shakeup and a controversial attempt to enter the copper mining business.

Goldcorp has Growth Potential

Despite its recent problems, Goldcorp has potential for future growth. The company has several major new mines scheduled to come online in the near future. It owns 40% of the Pueblo Viejo mine in the Dominican Republic, which is estimated to contain 25.3 million ounces of gold. Mining is expected to start there this month. Goldcorp and its partner, Barrick, hope to mine between 68,000 and 85,000 ounces of gold at Pueblo Viejo this year.

At Cochenour, near Red Lake in Ontario, Goldcorp hopes to mine between 250,000 and 270,000 ounces of gold a year beginning in 2014. The company will do further exploration work at the same site, so there could be more gold there.

The Eleonore mine near James Bay, Quebec is also supposed to go into production in 2014. This mine is supposed to produce 600,000 ounces of gold a year for 15 years. It is also supposed to have a low production cost of $400 an ounce, so it could be one of the company's most profitable projects. The $400 an ounce figure is just an estimate because real production costs there are unknown.

Gold production at the Cerro Negro project in Argentina is expected to begin in the second half of 2013. Production at Cerro Negro is projected to be 550,000 ounces a year, with a cost of less than $200 an ounce. That makes this project one that could add to Goldcorp's profits.

Work is scheduled to begin on the El Moro Project in Chile in September, which is scheduled to go into production in 2017. El Moro is expected to produce 210,000 ounces of gold and 200 million pounds of copper a year. Goldcorp owns 70% of El Moro, while New Gold (NYSEMKT:NGD) owns the rest. Production costs at El Moro are expected to be between $550 and $700 an ounce.

Goldcorp and New Gold have run into some problems at El Moro. In April, the Chilean Supreme Court canceled the permit for the project because its members felt the companies had failed to consult or compensate the local Indians. There are some other potential problems in operating in Chile, including serious power shortages that could affect operations or increase costs.

Goldcorp has several other mines on the drawing board, one of which, the Noche Buena silver and gold mine in Mexico, could come into production in 2015. The company's geologists estimate that there are an estimated 1 million ounces of gold and 32.4 million ounces of silver at Noche Buena. A feasibility study on this project is scheduled for completion this year.

Is Goldcorp a Value Buy?

Savvy investors will be wondering if Goldcorp could be a good value play. The company is going through some rough times, but it also has a lot of potential for leveraged profits. It has five new projects that could produce several hundred thousand ounces of gold a year and be ready to come online in the next few years. The company also has several other projects that could be big producers.

As of late 2010, Goldcorp had proven gold reserves of 23.3 million ounces in its existing mines. It also had probable gold reserves of 36.83 million ounces and estimated gold reserves that could be as high as 60.06 million ounces. The company also had proven silver reserves of 673 million ounces, copper reserves of 3,015 million pounds, lead reserves of 4,303 million pounds, and zinc reserves of 10,376 million pounds.

Goldcorp has tremendous assets, and it has demonstrated the ability to generate earnings per share in the face of losses and rising costs. Its expanding operations seem to guarantee growth for the near future. That seems to make it a better buy than competitors such as Barrick, and diversified miners such as Rio Tinto (NYSE:RIO) and Freeport- McMoRan (NYSE:FCX).

Goldcorp on Buffett's Wish List?

It is also easy to see why Goldcorp has popped up on Warren Buffett's supposed shopping list for acquisitions. Goldcorp was one of two major gold producers on that list. The other was U.S. based Newmont Mining (NYSE:NEM). The list also contained one of the world's largest nickel producers, Russia's OAO GMK Norilsk Nickel (GMKN). This company is also a major producer of gold and other precious metals. These three companies supposedly match the criteria for takeover that Buffett included in the annual report for his Berkshire Hathaway (BRK.A, BRK.B).

The figures above make Goldcorp a good value stock whether or not Buffett buys into it. The company has a high potential for leveraged profits and a demonstrated ability to generate profits, even in the face of losses and increased costs. More importantly, I believe it is poised for growth in both share value and cash flow in the next few years because of its expansion projects.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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